Mutual Fund

ICICI Prudential Nasdaq 100 Index Fund: What you should know!

Recently, ICICI Prudential has come up with the NFO for their new Index fund mimicking the US based Nasdaq composite Index. The media has been buzzing and the number of articles about why you should invest in the fund are available in abundance. This is probably the 3rd or 4th fund which enables the Indian investor to take exposure to Nasdaq Index [Other options are via Motilal Oswal & Kotak AMCs]. To save time of mine as well as yours, I’m not going to talk about what this fund is all about & it’s benefits. You can refer to the literature produced by the AMC in their presentation[Link]. We will try to discuss few specific points, that should enable you to decide, if you should add this fund in your portfolio or not. The fund is quite attractive from the perspective of potential ownership of the Big Tech names and next gen Innovative companies. Though as usual, I can not predict the future but I can look for the longer historical track record to make some reasonable expectations. We will try to look through the lenses of Risk & Return and it’s benefit to overall portfolio.

Caveats: Before we jump into the detailed numbers/ charts, Let’s understand that data I used is from the google finance for Nifty 50 Index, Nasdaq 100 index and Currency values. As the market operations differ in both countries, I tried to take the base as Nifty 50 & everything is calculated in the INR terms. The dividends are not included as it’s not the TRI data.

Let’s talk about returns first, I would use the rolling returns data and not the point to point returns as most of the articles and presentations are sharing. I am also going to look thorough the returns for a longer time horizon, Since Jan 2000 to Today a good 20+ years of history. One thing that flags from that analysis is that the last decade has been dominated by Nasdaq vs Nifty 50, though 2000-2010 has Nifty as a winner. Both these returns are in INR terms and do not include impact of Dividends. Overall If we take the Geometric mean of all the 1year rolling returns, Nifty takes the lead with 11% vs 8.6% of Nasdaq. Therefore, If the recent outperformance of Nasdaq is luring you to this fund beware of the lure. Please note that this is based on historic data so we do not know if this would hold true for Future or not.

In terms of risk, The returns of Nifty as well as Nasdaq has been quite volatile. Nifty returns have ranged between +99.4% to -55.5% vs the Nasdaq returns range of +95.5% to -64.3%. In terms of Max drawdown during the analyze period, Nifty had the worst drawdown of -59.4% vs -75.5% for the Nasdaq. Yes, That’s correct the Nasdaq had lost 3/4th of It’s value during the Tech bubble burst in 2000-01 period. In terms of Standard deviation, Nasdaq is slightly better off with 21.9% vs 25.6% of Nifty. Based on these data points, Nasdaq is less volatile but has higher drawdowns & swings to negative.

This does not make a great case for investment in Nasdaq 100 index as the mean returns are lower and risk parameters are comparable if not worse. Though we should not stop here on our decision, As I flagged in my article on Modern Portfolio Theory even if the standalone assets are risky the combination might have the diversification benefits. For e.g. I made the case to have gold in your portfolio for diversification benefit. In 2020, when markets had large drawdowns the rally in gold has cushioned my portfolio a lot and gave me confidence to deploy more money in equities at that opportune time.

Risk (Std Dev) on x-axis & Returns (Mean of RR) on y-axis

I am in awe of the above chart as it’s shape matches with the efficient frontier we have learnt during academic years. replicating something similar with real data & example is a great experience 🙂.

In the above chart, I have plotted 11 portfolio combinations, P1 is 100% Nifty to P11 is 100% Nasdaq. As you move across the Portfolios, you would notice that we would keep on reducing the volatility with increasing mix to Nasdaq and sacrifice some returns in process. This characteristic appears due to lower correlation (approx. 0.5) between these indexes rolling returns over the analyzed period. P4 (70% Nifty : 30% Nasdaq) has a similar volatility to Nasdaq index but adds +180bps on the returns, This means the investors should have higher exposure to Nifty to get a better risk adjusted returns. In real life, the correlations are not constant but dynamic and the realized benefit might be lower than expected as per the above chart.

Based on the above data points, I would say that Nasdaq is a risky proposition as an individual investment with higher drawdowns & lower mean returns for Indian retail investors like me & you . It definitely provides the diversification benefits but that would need an exposure of 20%+, If you plan to invest couple of % points or say 5-10% then you can give it a skip. We might be better off with taking global diversification using other options like S&P 500 or Developed world Index funds, though I have not analyzed so not recommending that yet.

Don’t jump on all the NFOs hitting the market, Follow the broad thoughtful portfolio which needs less changes to be a successful investor over a long term. Happy Investing!

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Investment Objectives & Advice

Nifty, Sensex are at all time high? Should you worry?

“When the facts change, I change my mind. What do you do, sir?” – John Maynard Keynes

The vaccine vengeance reflected in the Indian markets with Nifty moving +11.2% in Nov so far and Nifty Midcap 100 by +15.2%. To put this rally in context; Over the long term mean annual returns for the indices are probably in the similar range so you got a year worth of returns in a month (or missed it). If you compare these with the current dismal returns offered by the Debt instruments/ Fixed deposits 15% in a month is 3x to the annual FD returns of 5% in Large commercial banks. Such a large move in the month, when uncertainty around COVID is still prevalent, can trigger the various emotions regarding your portfolio decisions in this year.

Regret that you missed the opportunity to invest in March 2020, Greed to pump in more money in the current market run up to get some more returns, Fear that markets have been hitting all time highs and let’s redeem, Triumph that you killed that market by investing in march and now sitting on handsome gains or many more…

The best way to counter such dissonance is to rely on the facts and analyzing the facts. I have mentioned in one of the earlier articles why being rational pays off, may be its time to remind about the same. There are three main pointers floating around at present as below; we would analyze the all three in details.

  1. Earnings
  2. Valuations
  3. Liquidity

Earning growth in 2Q2021 (Jul-Sep 2020) has been drummed as a fantastic rebound of the earnings cycle and it has been used to paint a pretty picture of current markets after all market returns are highly correlated with the earnings. If I look at the standalone profits after tax for Nifty 50 companies in 2Q2021 INR 97,000 Cr, the earnings have grown by whopping 96%+ vs 1Q2021 and +39% vs 2Q2020. Now this standalone fact is pretty good to convince anyone about the earnings growth story. But If you decide to drill down this fact then the point worth remembering is that “In 2Q2020, we had the historic losses posted by Bharti Airtel (Loss of INR 24,500 Cr) after the court ruling. If we remove Bharti Airtel and compare the earnings of remaining 49 companies, we would have had the growth of mere 3.1% on YoY basis.” I am sure, I do not have to remind about the reason for lower earnings in last quarter given the lockdowns.

Nifty TRI/ Nifty PE Since Jan 2014 to Nov 27, 2020

If we look at the earnings trend Since Jan 2014, you would notice the flattish nature of the earnings so far. In last 6 years the CAGR for earnings have been <3% so should we expect the large earnings growth here onwards? Below is what I think:
1. Corporates definitely took the opportunity to cut the dead weights. They have cut down on the expenses and the Margins have improved. This should be long term positive
2. With the roaring market, lot of companies have raised the fresh capital and pared down the debts. The balance sheets have been stronger, which again is a long term positive
3. The banks would have been unscathed so far on NPA front given the moratorium and then the recognition as NPA needs 3 months of default so it might materialize only from the next earnings season. If we go by the RBI expectation of growth in NPAs then projection is bad. Banking is still the biggest sector in Index, hence this has potential to drag the earnings down

In summary, If I have to project the next 4 quarters of earning cycle then probably you might see some growth because we would have poor quarters to compare. Question is “Will the earnings growth be enough to push the markets further up”.

Valuations are sky high; This is the second narrative. The current Nifty PE is 35.66, which is one of the highest in last 20 years history. This as a fact is quite worrisome to cause the fear for investing. If I can borrow the below table from one of the earlier articles (Is index PE relevant), you can see that higher the PE levels the mean value of future returns keep decreasing. Let me also supplement this with the Valuation Index data from my workings as well, which also says the same that increasing valuations = lower mean returns.

Though we need to understand it bit better, the relation of valuations with returns is not extremely strong. From the VI Value table, you can see at in each Valuation Index range the Min & max returns have a dispersion of 100+ percentage points (For VI 6-7, Min -15.6% and Max 95.6%, the difference of 111.2%). Therefore, thinking only in terms of mean returns is not very wise. The only conclusion I would draw is that “higher the valuations, higher the chance of getting negative returns”. Therefore, the higher valuation levels should warn us but not demand to be 100% out of equity markets.

Liquidity is ample; This is the third narrative that the markets are flooded with extra cash and people are taking more risk given the risk-free rate is hitting all time low of 3-3.5%. This could be easily illustrated by the fact that AAA rating Corporates like NTPC are able to issue the commercial papers at <3%. The YTM for most Money market funds/ liquid funds is 3-4% in most cases. Banks have the optionality to keep the money back with RBI at 3.35% but Mutual funds do not. Let’s analyze the liquidity impact in two terms, first to understand if drives the market returns and second how sustainable will be the situation of excess liquidity.

In an earlier article, I did flag that valuations expand when the interest rate decreases (Importance of PE ratio). To put this theory in practice I analyzed the last 15 years data and compared the Nifty 50 TRI returns vs Valuation Index & 1yr Forward rate on T-bills, adding the T bills in regression improved the R2 of the regression [Ask for the file, if interested]. This ascertained that rates do play a part in projecting the future returns. Now, It’s important to understand the sustainability of the low rates. We are in the rare economic conundrum when the inflation is rampant/ increasing and GDP growth is negative; one needs the rate to go higher, while the other demands the opposite action. Rates might bottom out here with max 1 small cut or no change in next 1 yr but RBI would continue to use the non-traditional measures like OMO to keep the liquidity going. The market returns should not have any major impact of rates in next 12 months.

I can not predict the future but after analyzing these narratives, I am more inclined to suggest to be underweight on the equity as asset class. If your ideal Asset allocation to equity is 50%, you would be probably more prudent to keep only 30% allocation in current period. Remember that “To protect your downside, you need to let go some upside” as well as “To win the race, you need to run/ participate”. Lastly, if you are still not convinced about why you should be content and ignore the rally then read this statement of Jeffery Gundlbach “I turned negative on Nasdaq on Sep 30 1999, I was really negative. Of course, in the 4th quarter on 1999, it went up by 80%. But one year later, it was down 50% from the Sep 30th level.”

Let me know, your feedback/ suggestions. Till next time, Happy Investing!